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CA Intermediate · Financial Management and Strategic Management · Types of Financing

Under which of the following arrangements does a firm sell its trade receivables to a financial institution and the institution takes over the entire collection function and the credit risk of customer default (non-recourse)?

Non-recourse factoring is correct. The factor purchases the receivables, handles collection and bears the risk of customer default, so the seller has no liability if the debtor fails to pay. Under recourse arrangements the seller keeps the credit risk, which is the key difference.

  1. ABill discounting with recourse
  2. BNon-recourse factoringCorrect
  3. CTrade credit from suppliers
  4. DCommercial paper issue

Explanation

In non-recourse factoring, the factor buys the receivables, manages collection and bears the loss if the customer fails to pay. In bill discounting with recourse the seller remains liable if the drawee defaults, so the credit risk stays with the seller. Trade credit and commercial paper are not receivable-sale arrangements.

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